Asset-liability management is a process in which a company manages risks associated with a company's balance sheet. One tool used to manage risk is the calculation of EaR metrics. EaR is a concise measure of downside risk that may be defined as an assessment of risk that measures expected loss of earnings over a specified time horizon with a defined level of confidence. EaR may be expressed as an amount of forecasted earnings that is subject to low-probability, high-severity risk. For example, a company may estimate its EaR to be $47 million of GAAP net income (GNI) for a three-year period with a 5% probability. As the example illustrates, a basic expression of EaR would include an amount ($47 million), an earnings metric (GNI), a time horizon (three years), and a probability (5%).
EaR estimation for life insurance companies is an emerging practice that presents challenges of complexity that exceed those of the banking industry, for which EaR estimation is a relatively common and mature practice. In particular, the liabilities of life insurance companies are more complex than those of the banking industry and require approaches to modeling and scenario analysis that are more sophisticated than prior approaches in either industry. These liabilities may represent in-part the diverse product mix offered by insurance companies. For instance, a life insurance company may offer insurance products including term insurance, whole life insurance, universal life insurance (UL), and single-premium life insurance (SPL). In addition, fixed annuity products may be offered such as single-premium deferred annuity (SPDA), flexible-premium deferred annuity (FPDA), market value adjusted annuity (MVAA), equity-indexed annuity (EIA), treasury-linked fixed annuity (T-Link), and single-premium immediate annuity (SPIA). Moreover, an insurance company may also offer additional products such as variable annuities (VAs), guaranteed income contracts (GICs), medium-term notes (MTNs), structured settlements, and annuity buyouts (ABOs).
Therefore, there is a need in the art for a method and system for determining EaR estimates for insurance companies and similar entities to assist in managing risks associated with asset and liability portfolios. The system and method must provide results that are easily interpreted and useful to asset-liability risk managers.